Extreme volatility in a key funding market for banks as 2018 came to a close should serve as evidence that the US Federal Reserve ought to be prepared to serve as a backstop to prevent the market from seizing up, Bank of America Merrill Lynch analysts said on Friday. The $2.2 trillion repurchase agreement (repo) market enables banks and Wall Street to raise short-term cash to finance their trades and loans by using Treasuries and other securities as collateral.
On Dec. 31, the Secured Overnight Financing Rate (SOFR), a gauge on overnight repo rates, jumped to 3.15 percent, which was 75 basis points above the interest on excess reserves (IOER), or what the Fed pays banks on the excess reserves they leave at the central bank. Prior to the year-end spike, SOFR was running one basis point to six basis points above IOER.
If repo rates, some of which jumped above 5 percent that day, were to experience such sharp spikes more frequently, they could disrupt financial markets and cause other money rates to break above the top end of the Fed's target range.
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